Is it time to dive back into shares

Credit Suisse strategist Damien Boey says rates and yields in the US are low enough and will start to rise.
Photo: Michele Mossop

by
Brendon Lau

It may be difficult to believe amid the market turmoil but there are signs that this could be an opportune time for investors to get back into equities.

You won’t find consensus on this, however, as experts are still divided on whether the S&P/ASX 200 year low of 3985 on June 4 marks the bottom, given that Europe is still struggling with its debt blow-up and the United States faces a budget crisis in the new year.

Up or down, equity investors are likely to have a bumpy ride over the next few months.

But this is the kind of environment that appeals to experienced professional investors like David Bryant, the head of Australian Unity Investments.

“I am very big on now being the time to get back into equities," Bryant says.

“The S&P/ASX 200 has quite a resilient floor around the 4000 level and the reporting season has been pretty strong."

This view is backed by AMP Capital research, which finds that the outlook statements from last month’s reporting season are the most positive since February 2011. AMP believes equities will be higher by the end of the year.

Australia’s gross domestic product growth has also been fairly robust, with the second-quarter GDP figure rising at an annualised rate of 3.7 per cent, and Bryant sees little risk to Australia’s economic growth despite worries that the slump of more than 20 per cent in the iron ore price to about $US90 a tonne will erode our prosperity.

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“People confuse the [economic] environment with the strength of the corporates," he adds.

“The general health of Australian companies is as good as it’s been for some time."

Bryant also points out that the quality of stocks today is higher than before the global financial crisis, largely because the GFC weeded out companies with flawed business models, weak balance sheets and poor management practices. In spite of these positives, Australian equities are cheap on almost every fundamental measure.

Shares on the S&P/ASX 200 Index have a dividend yield of about 5 per cent, an unusually large premium to Australian government bonds.

While the index’s price-earnings multiple (essentially the ratio of a stock’s worth compared with its earnings) of 12.5 times is only a modest 10 per cent discount to the historical average, the price of shares compared to the book value of their assets is running at a discount of close to 20 per cent.

Fundamentals aside, this also looks like a good time to be buying into the sharemarket from a technical (or charting) perspective.

The charts are showing a strong “buy" signal, says Percy Allan, chairman of Market Timing, an advisory service that uses chart patterns and price movements to forecast the market.

“The Coppock indicator, which has correctly called the end of a bear market seven out of seven times since 1980, went positive in July," he says.

The Coppock indicator, or curve, is calculated using the weighted moving average of the rate of price changes of an index over two or more time frames.

Not everyone, however, believes it’s time to be wading back into equities, which has been one of the worst-performing asset classes over the past five years.

For every $1 invested in the sharemarket at the beginning of that period, only 65¢ would now be left, while those that invested in bonds would be sitting on $1.36 for every dollar invested. Even volatile hard commodities have outperformed shares.

The Commodities Research Bureau’s Spot Metal Index is hovering just north of break-even over the same period. September and October are likely to bring added stresses for equity investors.

“There is a calendar of things that can go wrong in Europe, particularly in the first half of September, and I think the market is too optimistic about the ability to solve intractable problems," says the director of capital market research at global asset manager, Russell Investments, Graham Harman. “Secondly, the VIX [volatility index in the US] and the way risk has been priced shows there is quite a bit of complacency around."

The German constitutional court is expected to rule next week on the legality of using Europe’s bailout funds to buy bonds issued by distressed European member states.

The ruling will have a big impact on the type of programs the European Central Bank can undertake to contain the European debt contagion.

On top of that, says Harman, we are also facing the “September and October jinx" – traditionally weak periods in the equities market.

WilsonHTM Investment Group analyst Damien Klassen believes there will be better buying opportunities later in the year, rather than now.

“We are in a gap in the cloud at the moment," he says. Klassen believes the market is being supported by hopes of large stimulus programs from the ECB, US Federal Reserve and Chinese authorities, which leaves plenty of room for disappointment if these fail to materialise. “A better buying opportunity is when we get more realistic earnings expectations, when we can see how far the Chinese slowdown has gone, and if the Aussie dollar falls a bit," he says.

The head of wealth management at Deutsche Bank, Chris Selby, does not recommend investors go overweight on equities at the moment.

“We are still a little cautious [about equities]," he explains. “We are pretty high in the 4000 to 4400 trading range that has been in place for the better part of the year.

“If you want to take on additional risks we would recommend hybrids and [corporate bonds]."

Selby prefers these securities as they have decent yields and offer downside protection in the event that the market corrects.

He doesn’t think the S&P/ASX 200 can break above 4400 until there is greater clarity on the macro economic risks.

International equities could have an edge over their Australian peers, says Credit Suisse strategist Damien Boey.

“We had Bill Gross from [global investment manager] PIMCO come out to say ‘this is the death of the equities cult’ and I think he is wrong," says Boey.

“I think this is the death of the bond cult in America."

Boey believes rates and yields in the US are low enough and will start to rise. This will tempt investors to move from bonds to telecommunications and utility stocks as they have higher yields than bonds and have less prospects of a capital loss.

“In Australia it is different," he says. “Aussie yields will not be able to match the rise in American yields because we have a housing problem to deal with and the debt-to-income ratio for households has gone up in recent years."

But this isn’t all bad for the sharemarket. Boey believes certain shares will do well, such as mining companies and high-yielding equities such as Telstra.

The interesting conclusion from these less bullish experts is that their argument against buying equities is not so much a valuation issue, but rather about timing.

In fact, just about all of them would agree that if you bought stocks now you would probably come out smiling in two years’ time. Ultimately, the decision to buy equities really comes down to whether you believe the global economic headwinds will abate significantly over the medium term.

Australian Unity’s Bryant believes equities can easily produce an 8 per cent total return in the coming years, and the returns to local investors will be even higher when franking credits are included.

“The biggest mistake people will make is to sit on their hands for another 12 months," he says. “If you wait until things become certain and all the experts are in agreement, it would be too late."